UK tax cuts
Dollar remains king
Credit Suisse shares plummet
New issue slowdown
Pull-to-par
Tenders offers
High yield issuance success
Floating Rate Note fails
NatWest Bank upgraded
Country upgrades
Cruise lines work hard to fund their futures
The British government’s largest tax cuts since 1972 caused the pound to drop to a level not seen since 1985 and gilts selling off very sharply in the hours after UK’s new Chancellor, Kwasi Kwarteng, delivered a tax slashing budget on Friday 23rd September. The pound sank to $1.09 and the yield on the 10-year gilt rose swiftly 23 basis points to 3.72%, a level not seen since 2011. The pound continued to fall to $1.07, and gilts reached yield levels not seen since 2008. The trounce wasn’t limited to the UK as U.S. Treasury yields climbed to the highest levels in more than a decade. By the end of the month cable recovered to $1.12, the 10-year gilt improved to 4.08%, and the yield on the 10-year Treasury bond reduced to 3.83% from its 14-year high of 3.95% a few days before. On the last day of September S&P placed the UK’s outlook to negative from whilst affirming its rating at AA. S&P cited concerns about the UK’s fiscal outlook and said the country ‘continues to face balance-of-payment risks stemming from its persistently large current account deficit, which we forecast will widen to 6% of GDP this year, in part driven by higher costs of energy imports.’
Global markets remain nervous over the potential impact of monetary tightening on the economy after central banks, including the Federal Reserve and the BOE, reiterated their resolve to contain runaway inflation. U.S. stocks ended the previous quarter with a third straight quarter of losses for the first time since 2009 after the Fed delivered a third jumbo hike last month. Markets now await the US jobs data later this week to gauge the path of the economy and Fed policy.
Dollar remains king
Our investment research processes have indicated for some time for us to be very underweight with our European currency fixed income exposures. We will maintain this theme going into the new year. Although it’s been difficult for bonds in any geography and in any currency, we have believed for years that Europe’s risk/return has not been compelling enough for us to invest. For this reason, we have not only stayed away from the euro currency but also continued to have low exposure to European based companies and financials. Our leading exposure remains the U.S. dollar currency and American financials and companies.
Credit Suisse shares plummet
It’s worth mentioning that Credit Suisse Group (CS) shares have now hit an all-time low after attempts to reassure markets on its financial stability only added to the sense of turmoil surrounding the troubled Swiss bank. The bank has lurched from crisis to crisis in the last 18 months, suffering a series of costly mishaps that have driven its share price down 60pc this year alone. Its bond prices have also dropped – steeply. The market environment is clearly challenging but the bank has high costs and poor governance rather than weak asset quality that has been damaging. The cost of insuring CS debt against default jumped to an all-time after attempts to reassure markets on its financial stability only added to the sense of turmoil surrounding the troubled Swiss bank. We have had a negative view on CS debt for a long time and we do not hold any bonds in the bank.
With the higher yields needed we are seeing an abrupt slowdown in borrowing with companies putting the brakes on their bond issuance ambitions. Last week we only saw $1.7bn of investment grade bonds sold with several possible borrowers standing down at the last minute. It wasn’t that long ago we saw companies in a now or never borrowing spree to beat ever rising interest rate levels. Equity market volatility and higher Treasury yields have produced an unpleasant environment for companies wanting to raise cash in global debt markets. With the 10-year U.S. Treasury now at 3.83%, up from just over 3% at the beginning of September, and higher bond spreads, it is getting very expensive for companies to borrow money. September high grade supply new issuance volume finished at $78.6bn, way below the expected $145bn. Looking forward the market is expecting to see just $75bn of new bond sales in October.
Pull-to-par
With the ever-higher yields and wider spreads, the global fixed income market has had a difficult time. The low yields seen in the past mean that new bonds issued in recent years have low coupons. In turn, with the rise in global yields these bonds are now priced below par - in some cases a long way below par. With bonds now trading at a discount they will be repaid at their face value on their maturity date. This means of course that over the period that remains to maturity, these bonds have an in-built profitability baring default. The ‘pull-to-par’ concept is a powerful one for capital protection. This is one of the opportunities that this current market turbulence can present to us.
Tender offers
We are seeing more companies taking advantage of their underperforming debt to buy-back their bonds cheaply. In the last week Softbank announced a $1.75bn bond repurchase and Aston Martin a previously declared £200m bond buyback after its successful £654m equity capital raise. With corporate debt trading at ever higher yields, and lower prices, there will be more companies offering bondholders the opportunity to sell their bonds back to the company. We expect to see more companies bringing tender offers in the coming months. There is a potential for a large debt tender offer from GE coming later in 2022 or early 2023 in conjunction with the spinoff of its healthcare unit. Every situation, and tender offer, is pitched at different levels of course, so whether its right to offer bonds back to a company must be taken on an individual basis.
Despite the general issuance slowdown investors did step up to fund one large high yield bond offering. A much anticipated $4bn bond sale for Citrix Systems, which is part of a$15bn debt package to fund its buyout from Vista Equity Partners and Elliot Management, was launched into the market. The offering, in the name of Picard Midco, came in mid-September was seen as a bellwether for high yield demand. At $4bn - the size was increased from the $3.5bn expected - it was the largest high yield deal for years to finance a leveraged buyout. The offering was sold at a deep price discount and a 10% yield. The senior secured note, that has a 6.5% coupon with a final maturity in 2029 and was priced at 83.651 to give a yield of 10%, widening from the earlier indication of 9.5% - 9.75%. S&P assigned a single B rating to the bond. The secondary market has seen the bond trade tighter with the price 1.5 points higher. Although successful in the end the deal wasn’t straightforward as not only the yield had to be much higher than first thought but the issuing banks were still left with bonds on their book. Whilst borrowing can still be done lenders are being extremely demanding and deals have to be pitched at the right level.
Floating Rate Note fails
Interestingly we have again seen companies dropping their new floating rate note tranches during the syndication process of their new deals. In September Toyota, NordeaBank and Citigroup all explored the idea of selling a floating rate bond tranche in their bond deal offerings but failed to get an appropriate level of interest. Perhaps this is surprising with the ever-rising interest rate environment.
NatWest Bank upgraded
NatWest Group, the bank formally known as Royal Bank of Scotland, seems to be continuing its road to recovery. In 2015 Moody’s knocked the banks’ senior debt to a sub-investment grade level of Ba1. After recovering its investment grade in 2017 Moody’s has continued to increase its rating level on the bank. A couple of weeks ago the rating agency increased NatWest’s rating up from Baa1 to A3 with a stable outlook. Moody's said, NatWest’s revenue will continue to improve in the next 12-18 months, as the group reprices its assets in a higher interest rate environment while only partially passing through rate rises to depositors and structural hedges provide further benefit to the net interest income; operating costs will only marginally increase, as inflationary pressures will be partially offset by cost-cutting initiatives. NatWest’s provisions against expected credit losses will be low in H2 2022 and 2023, as prudent allowance against credit losses (including post-model adjustments) previously made in the pandemic context will mitigate the impact of a weakening macroeconomic environment and loan book deterioration on credit cost. Moody’s also thought that NatWest’s profitability will also benefit from the phased withdrawal from Ireland, to be finalised in the next 12-18 months, and from the now-completed restructuring of the capital markets business, which in recent years dragged the group's profitability. September also saw Canadian rating agency DBRS Morningstar raising its BBBH rating to a positive outlook.
Country rating upgrades
September saw several countries upgraded, New Zealand, Portugal, Cyprus and even Vietnam all saw their ratings improve.
New Zealand was upgraded by Fitch to AA+ from AA with stable outlook. Moody’s and S&P have had AAA ratings on the country from years. Portugal’s government bond rating was raised by S&P from BBB to BBB+, stable outlook. S&P cited the country’s ‘strong growth, labour market, and fiscal outcomes.’ This is the country’s highest rating from S&P since 2011, when the country was downgraded to BBB from A-.
S&P also upgraded Cyprus at the beginning of the month by raising its rate by one notch to BBB from BBB-, with a stable outlook. S&P added that economic wealth levels in Cyprus will increase strongly through 2025, supported by the country's solid domestic demand and the ongoing recovery in the tourism sector. S&P also upgraded Bank of Cyprus to BB- from B+, with stable outlook.
Moody’s raised the ratings of 12 Vietnamese banks after the agency upgraded Vietnam’s sovereign rating to Ba2 from Ba3. Moody’s said the upgrade ‘reflects Vietnam’s growing economic strengths relative to peers and greater resilience to external macroeconomic shocks,’ Improved ‘policy effectiveness’ is expected to continue as the economy gains from shifting supply chains, export diversification and continued investment in manufacturing.
Not all countries were upgraded however - Turkey, Tunisia, and Ghana were all downgraded during September.
Cruise lines work hard to fund their futures
Cruise lines were one of the hardest hit sectors after the global outbreak of Covid in early 2020. Last month we discussed how Carnival Corp’s intricate financial deals to save the cruise line were getting ever more complicated. Now Royal Caribbean (RCL) has launched new bonds. RCL has frequently visited the debt market and a couple of weeks ago it came back to the market for the third time this year. In January RCL launched a $1bn 5-year senior unsecured deal with a coupon of 5.375%, which now appears very low. Unfortunately, since then the bonds’ price has fallen steeply to 74.00, a yield of around 12.75%. Spin forward to last month and RCL raised $2bn to help refinance all its outstanding 9.125% and 10.875% bonds both maturating in 2023. The launch is of a new $1bn offering of senior guaranteed notes and a $1bn offering of senior secured notes, both with 7-year maturities. The new bonds have coupons of 8.25% for the senior secured and 9.25% for the senior guaranteed notes both with a September 2029 maturity. Moody’s downgraded RCL in August to B2, five steps into sub-investment grade, from a B1 rating. That same month, the cruise liner paid 11.625% on another refinancing in the junk-bond market totalling $1.25bn. Moody’s attributed the downgrade to a weaker-than-expected recovery in 2022 which will leave the company with less than $1bn in earnings before interest, taxes, depreciation and amortization this year. The agency also cited the company’s large debt load that will need refinancing at likely higher interest rates and place pressure on its bottom line. Since launch both new bonds are trading wider with them loosing over 2 points in price.
Trevor Cooper FCISI
Chief Executive Officer
Chief Investment Officer
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